September 28, 2017

MONTH-IN-BRIEF: Securities Law

Cathy Dixon, Lisa R. Stark

Private Equity and Venture Capital

Chancery Court Clarifies Limits to Delaware’s Statute for Curing Defective Corporate Acts

By Sophia Dai, Stroock & Stroock & Lavan LLP

In Nguyen v. View, Inc., the Delaware Court of Chancery held that a venture-backed company could not use Section 204 of the Delaware General Corporation Law to ratify defective corporate acts that the company’s founder and majority common stockholder had expressly declined to authorize. In this case, preferred stockholders of defendant View, Inc. ousted View’s founder as CEO and then purported to implement a number of charter amendments, which required the founder’s approval, to dilute his ownership below the majority approval needed to effect the amendments. View then attempted to ratify the charter amendments under Section 204. Since its adoption in 2014, Section 204 has provided a practical mechanism for Delaware corporations to ratify defective corporate acts that might otherwise be void or voidable under the common law. However, as the court held in View, if a corporate act is expressly rejected by stockholders holding rights of consent, it cannot be ratified under Section 204. Furthermore, according to the court, Section 204 cannot be used to retroactively authorize acts that were never taken or to backdate acts that did occur to earlier dates. While Section 204 provides a statutory path for corporations to fix prior mistakes that might not otherwise be “fixable,” this case confirms that Section 204 is not a license for a corporation to fix all defects.

Securities Regulation

New SEC Guidance Simplifies Pay Ratio Disclosure Compliance

By Mark A. Borges, Compensia Inc.

Just in time for the 2018 proxy season, the SEC has issued guidance which significantly eases compliance with the new CEO pay ratio disclosure rule. The guidance clarifies that companies preparing to implement this rule may use (1) available tests to determine whether a worker is an “employee” or “independent contractor,” thereby eliminating one of the primary compliance burdens—determining whether contractors should be included when identifying the median employee; (2) existing internal records to identify the median employee, which should simplify data collection and analysis; and (3) any combination of reasonable estimates, assumptions, and/or statistical sampling to identify the median employee. Finally, the guidance provides that the pay ratio may be presented as an “estimate.”

International Securities Regulation

Hong Kong May Regulate Digital Tokens

By Jonathan Lawrence, K&L Gates

Following on similar statements issued by the U.S. Securities and Exchange Commission in July, in September, the Hong Kong Securities and Futures Commission (SFC) issued a cautionary statement regarding the classification of Initial Coin Offerings (ICOs) as securities offerings under the Hong Kong Securities and Futures Ordinance (SFO). According to the SFC, digital tokens offered and sold in an ICO could fall under the definition of “securities,” and dealing in or advising on digital tokens investments, or managing or marketing a fund investing in such digital tokens, may be subject to regulation. Parties engaging in a regulated activity targeting the Hong Kong public are required to be licensed by the SFC irrespective of whether the parties involved are located in Hong Kong, the SFC added. Parties engaging in the secondary-market trading of such tokens (e.g., on cryptocurrency exchanges) may also be subject to the SFC’s licensing and conduct requirements. The SFC statement also warns investors of the potential risks involved in ICOs and investment arrangements involving digital tokens. According to the SFC, ICOs pose significant money-laundering and terrorist-financing risks that could be addressed with proper safeguards. The SFC’s statement, while potentially undermining the flexibility of trading in digital tokens, did not go so far as China’s recent decision to halt all ICO-related fundraising activity.

Securities Regulation

Private Equity and Venture Capital

SEC Advisory Committee on Small and Emerging Companies Completes Final Report and Recommendations

By Ernest Holtzheimer, Montgomery McCracken

The SEC Advisory Committee on Small and Emerging Companies (the Committee) has recently issued its Final Report, which includes several recommended areas for the SEC’s continued focus after the Committee is disbanded on September 24, 2017. The report emphasizes the need to facilitate exempt offerings to help smaller businesses raise capital. In order to do so, the Committee recommended that the SEC provide regulatory certainty for finders, private placement brokers, and platforms that are not registered as broker-dealers by, among other things, expanding the "accredited investor" definition in Regulation D to include measures of investor sophistication. Beyond the scope of raising private capital, the Committee stated that the SEC must also address disproportionate burdens faced by smaller reporting companies (SRCs). To encourage more companies to go public at earlier stages, the Committee recommended extending to SRCs the same accommodations made under the JOBS Act to emerging growth companies (EGCs) with respect to certain disclosure requirements, as well as increasing the financial thresholds in the SRC definition so that more companies could qualify. Turning to its past efforts to increase diversity on reporting companies’ boards of directors, the Committee also recommended amending Item 407(c)(2) of Regulation S-K to require issuers to describe, in addition to their policy with respect to diversity, if any, the extent to which their boards are actually diverse. The Committee also recommended that the SEC improve secondary-market liquidity by preempting state regulation of secondary trading in securities of certain Tier 2 Regulation A issuers and by providing more trading support for small- and mid-cap companies by allowing trading increments (tick-sizes) in amounts greater than one penny.

Private Equity and Venture Capital

Stock Transfer Restrictions Held Ineffective

By Lisa R. Stark and Taylor B. Bartholomew, K&L Gates

In a recent opinion addressing stock transfer restrictions under Section 202 of the Delaware General Corporation Law (the DGCL), the Delaware Court of Chancery held that a stockholder was not bound by transfer restrictions that were not conspicuously noted on his stock certificates. In this case, the company adopted stock transfer restrictions pursuant to a stockholder agreement which provided that a stockholder’s shares may be reacquired for nominal value if the stockholder engaged in acts damaging to the company. Plaintiff later acquired company shares represented by a stock certificate that did not note the restrictions. When plaintiff sought access to the company’s books and records pursuant to Section 220 of the DGCL to investigate potential mismanagement, the company attempted to enforce the transfer restrictions by reacquiring plaintiff’s stock. The company then denied plaintiff access to the company’s books and records on the basis that he was not a stockholder and therefore was not entitled to the company’s books and records under Section 220. In this action, the court rejected the company’s argument that the transfer restrictions could be enforced against plaintiff, finding plaintiff did not possess actual knowledge of the transfer restrictions at the time he acquired his shares and did not subsequently assent to those restrictions. Transfer restrictions are routinely used in privately held and venture-backed companies to help ensure that a company has control over the identity of its owners. This case serves as a cautionary reminder that transfer restrictions may be invalid if corporate formalities are not followed at the time of adoption of the restrictions.

International Securitization

Significant Milestone Reached on EU Securitisation Regulation

By Maggie Zhao and Andrew Bryan, Clifford Chance

The EU Securitisation Regulation, long in the pipeline, recently reached a significant milestone when the political agreement was reached on provisionally agreed text. While political agreement was a welcome development intended to create a European framework for “simple, transparent and standardised” (STS) securitization, some provisions may present difficult issues for the securitization industry. One controversial piece of the proposed legislation is a last-minute insertion of a ban (in Article 17(2) of the provisionally agreed text) on securitizing self-certified residential mortgage loans. No provision has been made for secondary legislation or formal guidance that might be helpful in restricting the scope of this ban. Similarly, there is no de minimis exemption in the legislation. Although there have been suggestions the wording might be adjusted to significantly soften the impact, if the wording from the provisionally agreed text is carried through to the final text to be approved in late October and published in the Official Journal of the European Union later this year, the ban on self-certified residential mortgage securitizations may create significant problems not only for new transactions closing after the regulation becomes effective in January 2019, but also for existing transactions that need to be refinanced after that date. According to some estimates, £14 billion of existing transactions could be affected in the first year of the ban alone.

Cathy Dixon

Partner; Weil, Gotshal & Manges LLP

Catherine Dixon is a partner in Weil’s Washington, D.C. office and a recognized authority on the federal securities laws, as amended over the past decade by the JOBS Act of 2012, the Dodd-Frank Act of 2010, and the Sarbanes-Oxley Act of 2002. Her practice encompasses public and private company disclosure advice, capital markets transactions (including public and private offerings), mergers and acquisitions, corporate governance and compliance-related matters. Ms. Dixon is a member of Weil’s Public Company Advisory Group.

Lisa R. Stark

Counsel, K&L Gates

Lisa Stark advises boards of directors, board committees, and significant stakeholders on fiduciary and statutory obligations and corporate governance and M&A related matters. She has over 15 years of experience in mergers and acquisitions, strategic investments, initial public offerings, proxy contests, and hostile takeovers. Ms. Stark also advises private equity and venture capital funds in connection with their investments in Delaware corporations.